August 27, 2024

What is a Merchant Cash Advance & Is it right for you?

01 - Will a Merchant Cash Advance Help or Hurt Your Business@1.5x

Starting and sustaining a small business is costly. Many don’t even turn a profit until they’ve been up and running for years.

If your company’s struggling to stay afloat or needs a quick cash infusion to get off the ground, a merchant cash advance (MCA) is one option — especially if you don’t yet have enough assets to secure a traditional business loan.

But what is a merchant cash advance? And more importantly, will getting one help or hurt your business in the long run?

What is a merchant cash advance (MCA)?

An MCA lets you borrow against your company’s future credit and debit card sales. You inquire with an MCA lender, get a lump sum of cash upfront, and repay it with a percentage of your daily (or weekly) sales.

How do merchant cash advances work?

An MCA isn’t technically a loan, which means the total repayment cost and timeline are hard to predict. Instead of borrowing money and paying it back with interest over a set period, you essentially sell a chunk of your future income in exchange for immediate cash. How long your repayment period lasts depends entirely on your card sales.

Here’s the basic process for getting an MCA:

1. Apply. Put in an application with an MCA lender like Fora Financial or Libertas. The requirements are usually less strict than a traditional loan. You have to submit credit card statements, invoices, or other proof of income.

2. Receive funds. Once approved, the funds should hit your business account pretty quickly — often within a day or two.

3. Repay. Instead of making payments to the lender, they automatically take a portion of your card sales until you’ve repaid the advance, plus fees.

Not every business sees a lot of credit and debit card sales. If that’s true for your company, an MCA could still be an option. You’d estimate your monthly revenue and set up fixed repayments, which the MCA lender withdraws from your business bank account daily or weekly, even if your estimated revenue doesn’t wind up being accurate. For example, if you estimate that you’ll be able to pay back $1,000 per week but don’t make enough, you still have to pay $1,000 per month.

This process sounds pretty straightforward so far. But things get a little more complicated when you try to figure out exactly how much an MCA will cost your business.

Understanding merchant cash advance rates and fees

Unlike the interest rates of traditional loans, MCAs use factor rates. A factor rate is a multiplier (like 1.2 or 1.4) applied to the amount you borrow. The higher the factor rate, the more expensive the MCA. For example, you’d repay $14,000 for a $10,000 advance with a 1.4 factor rate. That same advance would cost $2,000 less if your factor rate were 1.2 ($10,000 x 1.2 = $12,000).

The factor rate isn’t usually the only cost associated with an MCA, though. Other fees might include:

Origination fees. This is the fee you pay upfront when you receive the funds.
Underwriting/funding fees. The MCA lender charges you for processing the advance.
Administrative fees. You’ll pay throughout the lending period to cover various costs associated with administering the advance.

It’s important to note that MCAs often lack traditional business loans’ strong regulations. This means you have less protection as a borrower, so do your homework to find a reputable MCA lender and protect yourself from unfair practices.

Unfortunately, the lack of regulation means doing your homework is much easier said than done. MCA providers have the flexibility to set high factor rates and layer on fees, which makes it difficult to compare true costs across lenders. And if your business winds up going deeper underwater than you were before taking out the advance, you may have fewer legal options available than you would with a conventional loan. While MCAs are helpful, they’re a slippery slope.

The pros and cons of merchant cash advances

MCAs are generally riskier than traditional business loans. But that’s not to say they don’t have any benefits. Here’s a list of pros and cons to help you decide if an MCA is right for you:

Pros

Fast approval. The approval process is usually fairly quick and painless, which is a big help for business emergencies or opportunities that require immediate action.
Fast funding. If you need cash within days, not weeks or months, an MCA’s fast funding can keep your business afloat.
Flexible repayment. Since deductions happen automatically, you won’t have a due date pressuring you to scrounge up funds when business is slow.
Less rigid qualification. Credit requirements for merchant cash advances are less strict than traditional loans, and you won’t have to put up (and risk losing) physical collateral.

Cons

Expensive (and confusing). Factor rates and extra fees make it tricky to deduce exactly how much the MCA will cost. You could wind up paying as much as 350% in interest.
No business credit. Like individuals, companies have credit scores. Some types of business financing help build business credit, but MCAs don’t — no matter how diligently you repay.
Lack of regulations. State-specific Uniform Commercial Code governs basic MCA transactions, but it doesn’t limit how much lenders can charge. That means you have to be very careful not to fall victim to predatory lending.
No perks to repaying early. Unlike loans that often charge less interest if you repay them early, the fees are already set when you take out a cash advance for your business.
Dangerous MCA stacking. It’s possible to take out multiple MCAs at once, but this often creates a crippling debt cycle, especially if your sales decline.

5 merchant cash advance alternatives to consider

Before pulling the trigger on an MCA, explore other financing options. You’re always better off going for a traditional business loan before opting for high-cost alternatives like MCAs.

If a traditional loan isn’t an option for your business, here are a few other paths to explore:

1. Business term loan

With this loan type, your business borrows a fixed amount and repays it over a set period with regular monthly payments. Interest rates are typically lower than MCAs, but you need to have good credit.

2. Business credit card

If you need money for small and mid-sized purchases, get a business credit card. You can spend what you need up to the limit, then pay the provider back with interest. Just watch out for potentially high interest rates if you’ll be carrying a balance from month to month.

3. Business line of credit

A business line of credit provides access to a pool of funds you can draw upon as needed, and you only pay interest on the borrowed amount. Think of it like a credit card. You can use it for short-term cash flow needs or fluctuating expenses.

4. Equipment financing

If you’re purchasing business equipment, you may be able to finance it directly with the vendor. The equipment usually serves as collateral to secure the financing, so if you can’t pay the installments, the vendor takes the equipment back. This is a good option if you need essential equipment but can’t pay the full amount upfront.

5. Small Business Association loan

The Small Business Association (SBA) provides government-backed loans, often through partner banks, with favorable terms and lower interest rates. The application process is longer, but small business loans from the SBA are usually the most affordable financing option for businesses that qualify.

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Please note, the material collected in this post is for informational purposes only and is not intended to be relied upon as or construed as advice regarding any specific circumstances. Nor is it an endorsement of any organization or services.